Friday, March 29, 2013

Selling out of the Bitcoin ledger

I'm starting to sell my position in bitcoin. I'll probably keep about 10% of my overall position but the rest will be repatriated back to the conventional fiat banking system.

Anyone who's been reading my bitcoin posts knows that I consider the fundamental value of bitcoin to be around zero. Consider what a bitcoin is. When you buy a bitcoin, you're basically securing a spot in a ledger. Bitcoin isn't actually a coin—it's just a key, a ticket, or an identifier, that indicates where in the ledger you sit. When people trade bitcoins among each other, what they're doing is swapping themselves into or out of that ledger. Space is limited. The amount of bitcoin in existence amounts to about 11 million, so there are only 11 million spots available.

Now there's nothing wrong with paying good money to secure a spot in a ledger. We've all done it before. When you buy an airline ticket you're basically buying room in an airline's ledger. The airline company carefully limits ledger space subject to its plane capacity. Your spot in the airline's records has a fundamental value. Come travel time, you can bring your ticket to the booth and redeem it for a real service—transportation. Would I buy a spot in an airline's ledger if I couldn't redeem my place in that ledger with air travel? Nope. It's not the spot in the airline's ledger that's valuable, it's the air time that the spot represents that's valuable.

Bitcoin is odd. Like an airline ticket, bitcoin is ledger space, but whereas a spot on an airline's ledger can be turned in for a real service, a spot on bitcoin's ledger can be turned in for, well, nothing. A bitcoin dangles in space, pointing at nothing. Despite its null value, bitcoin ledger space has been blessed by the market with a price of around ~$95, up from $11 just a few months ago. The market value of the entire ledger is moving in on $1 billion.

I would love to be able to create a ledger of my own and auction off space on it. Say I scratched out a 20x20 grid on a piece of paper and told the world that I had 400 spots to sell. A spot on my ledger would provide you, the potential owner, with no claim on my services whatsoever, but you'd be able to sell your spot in it to someone else whenever you wished. For me it would be free money, but I doubt any of you would bite. Why is it that people want to hold bitcoin space and not what I have to offer?

To begin with, bitcoin already has a positive value, giving it a huge advantage over spots in my grid, which don't. Second, the bitcoin ledger is an exceptionally cool ledger. Rather than my lame paper one, or an airline's centralized ledger, the bitcoin ledger is distributed. Hundreds of thousands of independent nodes all over the world store its data and work in a coordinated fashion to regularly update it. Bitcoin technology is fast and efficient. A user can instantaneously sell their spot in the ledger to someone on the other side of the world and, thanks to the architecture of the system, all parties to a transaction can be pretty sure that the spot being transferred isn't a fake or a counterfeit. Neat stuff, and people want to be part of it.

Despite these features, the fact remains that a bitcoin is little more than a spot on a ledger that points to nothing. It's dead-end, dangling ledger space. Without an anchor, bitcoin is free to rise 30% in two days, but likewise it can fall by more than that amount in an hour. Sure it's cool and edgy, but the waves of buyers who have moved into the bitcoin market because they like these attributes won't always be sufficient to prevent random shocks from knocking bitcoin's value down to nothing.

For instance, what happens when more ledger space enters the cryptocurrency market? This is already happening with the emergence of alt-chains like litecoin. But that's not the sort of ledger space I'm talking about. What happens when we bring in bitcoin-quality ledger space that has an anchor? I'm talking stable-value crypto-currency, not the sort that dangles and has a null value. These new alternatives will copy the best aspects of bitcoin, specifically its fast, efficient and safe record-keeping abilities. But rather than just providing blank tokens, they'll twin the ledger with some intrinsically valuable item.

Ripple, for instance, allows people to create and own IOUs, the transfer of which is recorded in the Ripple ledger. Or imagine if airline companies created standardized air time contracts and used a bitcoin-style record-keeping system to track trade in air time, leading to a new commodity money of sorts. In all cases—bitcoin, ripple, and air time—you get blazingly fast transaction speeds and low transactions costs. But with ripple and air time you're buying something real and stable, not just blank ledger space, whereas with bitcoin, you're still only buying a position in an empty ledger, with all the volatility that such emptiness entails.

A cascade-like process could ensue. As these stable-valued "ledgered" alternatives begin to steal cryptocurrency market share away from rudderless bitcoin, the price of bitcoin will deteriorate. This will only increase the rate at which people adopt alternatives, knocking bitcoin down further... and so on and so on to zero. Bitcoin could one day be like Friendster or Napster. These were the initial novelties that kick-started people's imaginations into creating new and ultimately superior versions of the original.

Of course, I could be dead wrong about all this. Bitcoin could rise to $1000 and will still be around in 10 years. If so, the tricky bit will be to re-conceive the the way I value assets and understand monetary phenomena. With that in mind, I'll keep a few bitcoins in my wallet. If I'm wrong, at least I'll be able to show some profits to balance things out.

32 comments:

you may or may not be right about what's going to win. I don't know, it's an empirical issue about the relative weight of factors.

But there is no fundamental issue here. Basically, you are saying that a network effect that's fully virtual doesn't have a chance against competitors. But we know from experience that that's not correct. IP addresses or languages exist, even though they are purely abstract constructs, there is no reason to assume the networks built on top of them (the internet or books) would be replaced by something fundamentally different. In particular the IP addresses are similar in almost all respect to Bitcoin, except they don't have low transaction costs. But they are scarce, trade at a significant price (in my thesis I believe I quote 17 USD/IP), are global, and not a high risk of being replaced. How likely is it that we'll stop using the entirely virtual internet and instead switch to "real" assets, such as the post office or the library? I don't think that's a realistic proposition, except for a "zombie apocalypse" type scenarios.

On the other hand, a system based on debt, even if you believe that redemption is secure (which even Ripple can't guarantee), if the leverage is increased too much, the whole system comes cascading down, and the insolvencies "ripple" (pun intended) through the whole net. We saw this with pirate's Ponzi scheme, and the passthrough funds built on top of it that were trading on the Bitcoin stock exchanges. We saw it with Cyprus. If debt comes crashing down, to quote Russel Peters, "somebody gonna hurt real bad". It might be you, it might be someone else, but someone has to pay. And if during this crash there is an alternative that is not suffering, people can switch and never look back.

Now, that being said, even though there is no fundamental theoretical issues, there could be empirical issues which shift the dominant position in the network effect this or that way. There could be technical glitches, or, on the other hand, innovations.

I'm not a fan of comparing valuable items like bitcoin, cash, gold or whatever, to language and words. Words are acatallactic, as Mises would say. They fall outside the realm of action based on monetary calculation. Bitcoin, on the other hand, falls within the realm of catallactics. So we shouldn't be drawing analogies between the two. Apples and oranges.

Unlike language and words, IP addresses do fall within the realm of catallactics, so let's focus on the IP address analogy. Furthermore, IP addresses, though purely abstract, are exactly like "real" assets (gold, cars, etc) in that they provide a non-monetary service. So my criticism of bitcoin isn't related to its virtuality -- my criticism focuses on bitcoin's lack of non-monetary value. When you strip out bitcoin's liquidity, tradeability, saleability, you're left holding nothing.

This wouldn't be the case if bitcoin "pointed" to something. Even if bitcoin was a virtual claim on a virtual IP address, this would give a bitcoin some real, non-monetary value, and that would be sufficient to give it a stable value over time. And then I wouldn't be a seller.

Anyways, it think we've had this argument before. To top it off, it's looking like I'm wrong already, and bitcoin is heading over $100.

I would have though that you in particular, due to your insistence on "moneyness" instead of "money", would understand my point. Moneyness is just one of the examples of the network effect. It's not really "special". It just causes a lot more confusion, anger, emotions, and fake experts than other examples of the network effect.

You say that words are acatallactic. But that's not true. Words are a means. It's difficult to classify them using the misesian terminology, but it can maybe help if you view them as a catalyst. They are not really necessary in any act of consumption or production, but they make make such acts more efficient. Same with moneyness (or liquidity, whichever you prefer). It makes trade more efficient. It does not literally make trade possible, i.e. we do not invoke it due to a physical effect, it just influences our evaluations of choices. It allows us to achieve our goals more efficiently. The whole concept of "backing" or "pointed to" is just baggage that we carry along due to our historical experiences. It's implicit assumption that we can't get rid of, because we've been carrying them along our whole lives. And many of the Austrians suffer from the same problem too.

Maybe the internet generations are not bogged down as heavily, and can appreciate virtual existence more readily.

You're blogging. What's a blog? What does it "point to"? Nothing. It's completely virtual. But you are real, and your readers are real. You have your reasons for writing, and they have reasons for reading and commenting. You (and they) pick the internet and English as means for doing this. Similarly, people have their own reasons for trading, and they will pick a medium of exchange based on those needs to trade. All other arguments are irrelevant.

Catallactics is the study of exchange, and words are not exchanged, although bitcoins are. But let's leave off on that.

Maybe I don't appreciate virtual existence, so let's abstract from so-called virtuality. It's 1546 and a monk has trained a flock of pigeons to quickly transfers tiny rocks across long distances, very quickly. The rocks are limited in quantity, and each one is etched with a unique marking so it can't be copied. The rocks have no non-monetary purpose whatsoever. In most circumstances, they lie unused on the ground. Up till then, no one has developed a fast and efficient technique for transferring small rocks.

All I'm saying is that despite the blazing speed of the monk's system, I'd be surprised if his rocks gained a positive price. If they did, that price would be very tenuous. The way to give his rocks a non-tenous price would to have each stone represent something, like a debt, or some quantity of gold.

the boundaries of goods are more-or-less arbitrary, unpredictable, subjective and ever changing. By writing and reading, we influence other people's choices. That's social interaction. I think you are taking definitions too literally and focus too narrowly.

There's no way in my opinion that BTC goes down this year, at least. In April, when Silicon Valley Bank (SIVB) takes over Mt. Gox's business in the US, we can expect the process of buying and selling BTC for USD to become much easier. Merchant adoption will also continue to increase this year.

If SIVB convinces a lot of people to let them warehouse their BTC, couldn't SIVB conceivably expand its lending (by cutting its spreads) with the warehoused BTC as the frac reserve base? It seems likely that BTC depositors will sit on a significant portion of their savings for the time being, so a BTC "run" wouldn't likely be a problem. SIVB wouldn't even need to pay interest on these deposits, since a lot of people would simply be glad to outsource the process of securing their BTC.

"What would cause the first two to decline? Alt-chains just don't seem like a credible threat for now."

Liquidity/tradeability/saleability can be highly unstable. An asset is highly liquid... until it's not. Some random shock could do it. Moldbug hypothesized a government shutdown of major exchanges. I'm putting forward the stable-value alt-chain theory.

BOFI is a pure internet bank, no physical branches and way less overhead than traditional banks. Not really related to BTC, but thought you might be interested in this type of development.

http://finance.yahoo.com/q/co?s=BOFI+Competitors

Govt shutdown--can never rule this out. Still, having a legitimate bank (SIVB) working with BTC helps tremendously on the lobbying front, I think. The faster BTC is integrated into the financial industry, the more of a stink will be raised in the event of a crackdown.

Like I said, in the short term, things like Coinlab/SIVB should only increase liquidity, and lowered fees for merchants should drive acceptance/tradeability for real goods. These developments aren't written in stone, but to argue otherwise requires a good explanation. I respectfully submit that you haven't provided one yet.

Stable-value alt-chain (i.e. Ripple)--yes, long term I think this is a potential threat. But it's going to take time for Ripple to get off the ground (at least a year or two). And I'm still not sure how XRP will be a competitor to BTC. IOUs will be payable in USD, but I imagine most early adopters will gladly accept BTC, too. What am I missing?

No, XRP wouldn't be a competitor, but I could see USD ripple IOUs and fractionally-backed BTC ripple IOUs as being replacements.

I'm just giving a few hypotheticals. It could be any sort of shock that gets the process going, a butterfly flapping its wings in Brazil so to say. When it comes to the other assets in my portfolio, I'm less worried about butterflies in Brazil, but my other asset's aren't pure balls of liquidity. Incidentally, the fact that bitcoin is 100% moneyness is also what makes it such a great speculative asset --- there's no reason it can't rise 50% in a week, and 50% the next week, and 50% the next week. Other assets can't do this.

You also miss something else. Yes, because Bitcoin is 100% moneyness, its value can go up and down. But also, because its low transaction costs and limited supply, there is little reason for any other liquid assets to exist. In other words, Bitcoin is like a singularity, sucking all liquidity from all other goods. Bitcoin has the potential to de-monetise (or, to preclude your objection, de-moneynessise) all fiat monies (fiat moneynesses) that we know.

JP, your argument here appears to be that, because bitcoin has no non-monetary value, it is not a valid form of money. Why should that be so? I thought the premise of this blog was that moneyness itself (which bitcoin has aplenty) imparts value? Why should we need to consider stripping out bitcoin's liquidity, tradeability, saleability?

"JP, your argument here appears to be that, because bitcoin has no non-monetary value, it is not a valid form of money. Why should that be so? I thought the premise of this blog was that moneyness itself (which bitcoin has aplenty) imparts value?"

Good question. I'm not saying anything about bitcoin being a valid form of money or not. I'm saying it's a very odd asset. Bitcoin has no non-monetary value, it is pure moneyness. Moneyness imparts value --- it gets built into an asset's price as a liquidity premium. But most goods only have small liquidity premia. Bitcoin is all liquidity premia.

"Why should we need to consider stripping out bitcoin's liquidity, tradeability, saleability?"

In a typical market, there will be an even mix of people interested in buying some asset for both its moneyness and its non-monetary qualities. When all of the buyers of the first type suddenly leave, the latter type of buyer will still be there to support prices. In bitcoin's case, the only type of buyers are the one's interested in moneyness. When they leave, bitcoin collapses to 0.

JP, thank you for your reply. Perhaps the point I was trying to make was that, from an investment perspective, it's not really clear to me why there's any significant difference between a market whose moneyness premium is 99% or 100% of the asset's value. Either way, if the moneyness-seeking buyers decide to leave the market, as an investor, you're screwed. (It's possible you're indirectly referring to the regression theorem, but I'm not sure).

JP, you seem to be paying very selective attention to what's happening with Bitcoin. No shocks have ever "knocked it down to nothing." Please sell 100% of your position if you're going to post negative nonsense about it.

Bitcoin value will never fall to nothing. As it approaches 0.00001 USD/BTC, I swear I'll buy all 11 millions of it. For its collectible value, if not for anything else. And I'm not alone in this, people will start to frantically buy it up long before it even approaches 0.00001.

For all the moneyness talk, you seem to have little understanding of HOW new money come into being. Maybe, this article will help you to see the light: http://szabo.best.vwh.net/shell.html

Bitcoin is a new form of money, but in gaining value it follows the same trajectory as rare shiny stones, cowry shells and then "precious" metalls many, many thousands years before. I bet our ancient fore-bearers we quite puzzled by the inexplicable raise in value of a soft and heavy metal that was quite useless for any kind of productive work...

"For all the moneyness talk, you seem to have little understanding of HOW new money come into being."

I too find early examples of trade media interesting. See my post on yap stones.

Bitcoin as collectible, curio, or symbol of geek cred is an argument we've kicked around on this blog before. See Mike Sproul here. It's not unreasonable. Perhaps large amounts of buying is being motivated not for monetary reasons, but for these semi religious/ceremonial reasons. If so, bitcoin is not as unstable as I make it out to be.

But I'm not convinced. My intuition tells me most of bitcoin's value is speculative, or monetary, and so I'm a seller.

It is not just about a curio or geek-cred value. Szabo argues that human propensity to hoard rare and unfakeable collectibles is the very origin of money, and I find his argument convincing. In order to become widely used as money, though, such collectibles also needs to be as close as possible to Aristotelean ideal money.

Any kind of money that the human societies used in the past, be it yap stones, cowry shells, precious metal rings/coils and later gold/silver coins, must have gone through similar value bootstraping process, initially driven by their desirability as a collectible. We just do not find any evidence of these events because they played out so long ago.

Now, bitcoin is a new kid of money going through the same value bootstrapping process. It is much closer to Aristotelean ideal money than anything that existed before it. However, because of its highly technical aspects, initially only a small portion of human population with above average technical skills was able to understand this. So, bitcoin initially became a "geeky collectible". However, the knowledge tends to spread, and as more and more people start to look closer into bitcoin, and appreciate its characteristics, this "collectible rush" will only accelerate.

This is exciting because we are witnessing first-hand the birth and bootstrapping of new major money. We've missed the time when it happened with gold by about 10,000 years. But with bitcoin, it is happening right before our eyes. Trying to apply labels such as "speculative" to this process, as if it were just another "financial asset bubble", explains nothing. Yes, speculation may well be part of it, but it does not capture the essence of what's happening here.

And yes, Ripple is interesting on its own right, and I'm buying XRP to get first-hand understanding of value bootstrapping process. Ripple and bitcoin are quite complimentary, and both will most likely be the key structural elements of post-fiat monetary systems.

+1 Arvicco. We're experiencing something that economists have hypothesised about for hundreds if not thousands of years, yet when it's happening right in front of their eyes, most of them don't understand it. I'm not saying they should agree with it, but if they can't recognise it, that tells you a lot about the usefulness of their expertise.

If you are using Bitcoin to buy stuff or move money around, it actually does provides a service.

Now, what you are talking about is: bitcoin as value storage.And in that case, the value of "anything" is whatever you are willing to pay for it.So the value of anything as a mater of will/trust.If you have a Ton of gold but nobody is willing to pay you for it... it worthless.

What you are actually telling us is: you trust your government will not go bankrupt, rendering your fiat to paper and tin, now, i will not argue with you about whom you trust!

In the end bitcoins is backed by the trust of its users, as a whose, in bitcoin, so it does point to something, and its as real (or unreal) as any fiat currency: trust in the system!

Also "A bitcoin" is something that does not even exist by itself! There is no such thing.Bitcoin is the unit of what is being held in your wallet, just like the number of meters/kilos/kelvin!Just like a dollar in your bank account!

In it he suggests the idea of private currencies whose issuers guarantee the value of the units of their currencies against a fixed anchor (such as a basket of goods - similar to what might be used in an inflation targeting central bank set-up).

The issuers of such currency would need sufficient assets in order to provide confidence to users that they could keep their commitments. Depending upon the credibility that they could indeed keep their commitment they could then charge transaction fees for use of their currency and (potentially "storage" fees for the use of their currency as a unit of value).

The internet and the example of bitcoin seems to open upon possibilities beyond those that Hayek imagined.

Do you think that such an idea is viable ?

BTW: One of things I love about your blog is that after a really interesting article that demonstrates your specialist knowledge in this field you end wth :

"Of course, I could be dead wrong about all this. Bitcoin could rise to $1000 and will still be around in 10 years."

I have Hayek's "Denationalisation" in my book shelf and am a big consumer of the body of literature that Hayek inspired, including White, Selgin, Glasner, and Horwitz. Actually, the subtitle of my blog - "moneyness is best thought of an adjective, not a noun," - is inspired from a passage in Hayek's book.

There are different strains of free banking, but the core idea at all of them -- that the provision of all monetary services can be handled competitively -- is certainly a worthwhile idea.

I want a space on the grid! Are they starting with an auction? I bid ฿0.0001 for square 7x7! How do I rephrase that so the auction bot gets it? Bot, yo bot!! 2nd law, obey me!! +bid ฿0.0001 7x7 or whatever!! Wait how did you say these grid squares are secured/transferred? They're on paper? What kind of bot rewrites the square and what's the fee? That sounds kinda cool I assume there's a webcam where I can watch? Wow just ฿0.0001 and so far I'm the owner of a genuine square of paper! Take that Bitcoin!

When I was little smart property was the future and now it's our present. We present you this present. You're right that Bitcoin has little value beyond being a brand name. But what a brandname it is. Brandname Bitcoin, get them while they're hot. I like Litecoin a lot but they're still a little harder to sell. ;)